Category Archives: Gina Correia

Indemnification and Advancement of Directors and Officers for a Utah Corporation Doing Business in California

Corporate counsel is asked to make many decisions on behalf of a corporate client. A corporate client may seek advice on choice of law selection or where it should incorporate. At the initial founding stages, many clients do not consider that the place of incorporation and choice of law will affect the corporation’s obligations to indemnify and advance expenses to directors and officers.sealofutahstateseal

For this analysis, even if the client chooses to incorporate in Utah, if most of its business is being performed in California, it will be deemed a “quasi-California” corporation pursuant to California Corporations Code section 2115 and will be made subject to several California laws regulating corporations.[1] If the corporation wants to initiate a lawsuit against a director or officer that has failed to act in the best interest of the corporation, counsel must consider where the corporation should file the lawsuit. Crucial to this consideration is that California and Utah have different standards for granting indemnification and advancement of expenses. The choice of forum will dictate the requirements and obligations of the corporation to advance and indemnify its officers and directors.

Indemnification:

A Utah corporation that meets the requirements set forth in California Corporations Code section 2115 will be deemed a “quasi-California” corporation and will be subject to a host of expressly delineated laws regulating out-of-state corporations. Included in the list of applicable provisions is California Corporations Code section 317, California’s law on indemnification and advancement. Section 317(e) provides the law on indemnification:

“any indemnification under this section shall be made by the corporation only if authorized in the specific case, upon a determination that indemnification of the agent is proper in the circumstances because the agent has met the applicable standard of conduct …”

The indemnification provision of section 317 is limited by a standard of conduct determination, meaning that the corporation will have some ability to control who receives indemnification and who does not. The standard of conduct set forth in section 317(b) requires a determination that the person to be indemnified “acted in good faith and in a manner the person reasonably believed to be in the best interest of the corporation…” By comparison, the indemnification statute in Utah operates the same way, requiring the corporation to make a determination that the person to be indemnified has met the applicable standard of conduct and has taken action in good faith and in a manner he or she reasonably believed was in the best interest of the corporation.[2] With little variance between the indemnification provisions in California and Utah, it could be expected that the law on advancement would also be similar. But that would be an incorrect assumption.

Advancement:

The Utah statute on advancement is similar to the indemnification statute, requiring that, “a determination is made that the facts then known to those making the determination would not preclude indemnification…”[3] However, unlike the Utah statute, the advancement provision in California is not limited by a standard of conduct determination, or any determination at all. Instead, the California advancement statute states:

“Expenses incurred in defending any proceeding may be advanced by the corporation prior to the final disposition of the proceeding upon receipt of an undertaking by or on behalf of the agent to repay that amount if it shall be determined ultimately that the agent is not entitled to be indemnified as authorized in this section.”

See Cal. Corp. Code § 317(f).

The only requirement for advancement under California law is that the person seeking advancement deliver an undertaking to repay the amount advanced if it is ultimately determined that he or she is not entitled to be indemnified. It is unclear whether the delivery of an undertaking requires anything more than a written promise to pay back any amounts advanced.

This is an important and interesting distinction between California and Utah law, and one that counsel must consider in evaluating disputes between a Utah corporation and its officers and directors. The result of choosing to apply California law is that the corporation might be obligated to provide advancement to its directors and officers without any determination of whether that person meets the applicable standard of conduct, limiting its ability to deny advancement those who have acted outside the best interests of the corporation.

[1] For the full list of provisions quasi-California corporations are made subject to, see California Corporations Code § 2115(b).

[2] Utah Revised Business Corporation Act 16-10a-902(1).

[3] Utah Revised Business Corporation Act 16-10a-904(1).

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For more information about this topic, contact Gina Correia at (818) 444-4500 or gcorreia@stubbsalderton.com.  Gina Correia is a litigation associate of the Firm. Gina’s practice focuses on all stages of business litigation. Prior to joining the firm, Gina worked in-house as a business affairs law clerk for HBO. Gina’s prior experience in the entertainment industry focused on talent engagement negotiations including drafting contract request, calculating actor, producer, and writer fees for top-tier talent, and evaluating comprehensive deal points. Gina also previously worked for The Los Angeles Office of the District Attorney in the Consumer Protection Division where she researched and analyzed wire-tapping violations under Penal Code and Federal Trade Commission guidelines.

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Doing Business in California: “Quasi-California” Corporations Made Subject to California’s Corporate Laws

smallerMany, but not all, provisions of the California Corporations Code expressly apply if a private, out-of-state corporation has a sufficient “presence” in California (called a “quasi-California” corporation.) An out-of-state corporation is treated as a “quasi-California” corporation, and thus subject to specified provisions of California Corporations Code, if (1) more than half its business (based upon a three-factor formula including property, payroll, and sales) is done in California (the “doing-business” test); and, (2) more than half of its voting securities are held of record by persons having addresses within the state of California (the “voting-shares” test).[1]

For analysis, hypothetical SmallCorp, Inc. is incorporated outside of California with substantially all of its business performed inside California.

Hypothetical Illustration: Does SmallCorp, Inc. Satisfy the Requirements of § 2115(a) to Qualify as a “Quasi-California” Corporation?

 A.    The “Doing-Business” Test

To satisfy the “doing-business” test, a corporation must do more than half of its business in California. The three “doing-business” factors are: (1) property, (2) payroll, and (3) sales. The first question is whether the proportion of a company’s property, payroll, and sales in California compared to the company’s total property, payroll, and sales is more than 50 percent during its latest full income year. (See Corp. Code §2115(a)(1).)

To determine whether the factors meet the one-half doing business requirement, sections 25129, 25132, and 25134 of the Revenue and Taxation Code define the factors as follows and provide the necessary equations:

· the property factor is a fraction, the numerator of which is the average value of the taxpayer’s real and tangible personal property owned or rented and used in this state during the taxable year and the denominator of which is the average value of all the taxpayer’s real and tangible personal property owned or rented and used during the taxable year;

· the payroll factor is a fraction, the numerator of which is the total amount paid in this state during the taxable year by the taxpayer for compensation, and the denominator of which is the total compensation paid everywhere during the taxable year; and

· the sales factor is a fraction, the numerator of which is the total sales of the taxpayer in this state during the taxable year, and the denominator of which is the total sales of the taxpayer everywhere during the taxable year.

Thus, if the average of the property factor, the payroll factor, and the sales factor is greater than 50 percent during its latest full income year, the “doing-business” test is satisfied.

Assume SmallCorp owns property such as products, machinery, office equipment, and also rents office space in California. SmallCorp does not own or rent any property in any other state. So, the equation is as follows:

(1) Property —-> property in CA / all property    =   1/1       = 100%

SmallCorp has several employees, 90% of whom live and work in California. Accordingly, SmallCorp pays 90% of total compensation paid to all SmallCorp employees to those who live and work within California, as demonstrated below:

(2) Payroll —>   amounts paid in compensation in CA / total amounts paid in compensation =  9/10  = 90%

For this hypothetical, because the first two factors result in 100% and 90% of business performed in California, even if 0% of sales, the next factor, occurred in California, SmallCorp would still do more than one-half of its business in California, satisfying the “quasi-California” requirements. Assuming SmallCorp has no sales in California, the equation is as follows:

(3) Sales —>  ​sales in CA / all sales   =  0/1   =    0%

This conclusion is reached by taking the average of 100%, 90%, and 0%, then dividing the total sum (190%), by the count (3) which equals 63.3% of SmallCorp’s business is done in California.

For a more representative hypothetical, assume that SmallCorp does 70% of its sales in California. If sales are 70% in California, the amount of total business performed in California is 86%, using the same formula: (total sum ÷ count). Accordingly, the proportion of a SmallCorp’s property, payroll, and sales in California compared to the company’s total property, payroll, and sales is more than 50 percent and the “doing-business” test is satisfied.

B.     The “Voting-Shares” Test

The second test is whether the corporation’s outstanding voting securities held of record by persons with California addresses is greater than 50 percent. (See Corp Code §2115(a)(2)).

Assume there are two voting shareholders in SmallCorp: Arnold and Ford. Arnold’s address is in Hermosa Beach, California. Ford’s address is in Orange County, California. Thus, both shareholders of voting securities have addresses in California. The “voting-shares” test is satisfied because 100% of SmallCorp’s shareholders have addresses in California.

​SmallCorp will qualify as a “quasi-California” corporation under section 2115(a) because more than 50 percent of its business is done in California and more than 50 percent of its voting shares are held by shareholders with addresses in California. As such, corporate counsel should consider the additional requirements that California will place on a corporation that is “doing business” in California pursuant to section 2115(b), including the imposition of specific sections of the California Corporations Code.[2] For that reason, this long-arm statute’s constitutionality has been called into question by courts of other jurisdictions.

gina-correia_092-2-300x200Gina Correia is a litigation associate of the Firm. Gina’s practice focuses on all stages of business litigation. Prior to joining the firm, Gina worked in-house as a business affairs law clerk for HBO. Gina’s prior experience in the entertainment industry focused on talent engagement negotiations including drafting contract request, calculating actor, producer, and writer fees for top-tier talent, and evaluating comprehensive deal points. Gina also previously worked for The Los Angeles Office of the District Attorney in the Consumer Protection Division where she researched and analyzed wire-tapping violations under Penal Code and Federal Trade Commission guidelines.

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